What's in a purchase price? It's all based on your perspective

With football season on the horizon, I can't help but think about Sept. 24, 2012 — a night that many football fans will not soon forget. The Seattle Seahawks were playing the Green Bay Packers on Monday Night Football.

The game was down to the wire and Seattle trailed 12-7 with only a few seconds remaining. With time expiring, Seattle quarterback Russell Wilson heaved a 24-yard pass to receiver Golden Tate in the end zone. Green Bay defensive back M.D. Jennings positioned himself in front of Tate and elevated to intercept the pass. Thunk! Jennings ended up with the ball tightly secured against his chest on the way to the ground … with Tate desperately grasping at the ball from behind Jennings as he lay underneath him in the end zone.

After numerous replays, the referees (who happened to be replacement officials since the regular officials were on strike) ruled that Tate had caught that ball for a touchdown even though Jennings had it securely in his grasp. The ruling may go down as one of the worst calls, if not the worst, in NFL history.

That was a great night to watch football for the casual fan — a close game with a dramatic and controversial finish. For Seattle Seahawks fans, it must have been a night of wild ups and downs with the game ending on a resounding upswing. It was likely one the worst nights in recent years for Green Bay Packers fans: losing a game due to a blatantly incorrect call with no time left on the clock.

The biggest winners of all may have been the NFL referees, with whom the NFL quickly reached an agreement on a lucrative new contract in the days following this replacement refereeing debacle.

This game shows a single outcome can mean many different things to different people based on their perspective. The same concept applies to transaction purchase prices. A single purchase price can be presented many different ways, each with its own meaning yet all based on the same agreed-upon amount. Below are three common ways that a single purchase price may be calculated and presented:

Cash paid: This is the simplest approach to presenting a purchase price, but looking at this alone can be misleading. It is not uncommon for purchases to be reported based on the amount of cash paid at closing, but it doesn't consider other components of the purchase price that may end up being well in excess of the cash paid at closing.

GAAP purchase price: The purchase price of a transaction under generally accepted accounting principles (GAAP) includes not only cash paid at closing, but also the value of any stock issued to the seller, deferred payments or contingent consideration. Contingent consideration is often structured in the form of an earnout in which the buyer must make additional payments to the seller if certain targets or thresholds are met. GAAP requires that the fair value of any contingent consideration be determined as of the transaction date and recorded as a liability on the acquirer's balance sheet, effectively treating it as part of the purchase price.

Enterprise value: In the valuation of the intangible assets of an acquired company after a transaction is complete, enterprise value is used as another derivation of purchase price. It is based on the GAAP purchase price plus the value of any interest-bearing debt assumed in the transaction. Enterprise value is often considered the value of a company as a whole, regardless of how it is financed.

Based on these three perspectives, the purchase price of a transaction can look vastly different. Let's assume that a transaction calls for $10 million in cash to be paid up-front, $50 million in stock to be issued to the sellers, an earnout of 5% of revenue from the sale of an in-process research and development project capped at $100 million (the fair value of which was determined to be $35 million), and the assumption of $150 million in debt. The various purchase price amounts would be as follows:

As evidenced by this example, a single purchase price can be interpreted in many different ways, much like the outcome of the Seahawks-Packers game. Therefore, when considering the prices of various transactions, it is important to know how those prices have been calculated so that you have a consistent perspective and are not comparing apples to oranges (or footballs).

Reader Comments

Readers are solely responsible for the content of the comments they post here. Comments are subject to the site's terms and conditions of use and do not necessarily reflect the opinion or approval of Crain's Cleveland Business. Readers whose comments violate the terms of use may have their comments removed or all of their content blocked from viewing by other users without notification. Comments may be used in the print edition at editorial discretion.